September 9, 2019

Have We Left Low Prices Behind?

 |  By: Robin Schmahl

The dairy market has been showing some interesting variations so far this year. To some degree it seems as if traders are not aware of what is going on, but I am sure that is not the case as they watch the market closely. However, traders have a tendency to look over their shoulders at the previous year or years and will continue to trade a historical pattern unless it proves itself otherwise. This seems to be one of those years again. 

First, if we look at daily spot trading we see that block cheese price has been on a basically steady uptrend since the beginning of the year. As of Friday, September 6th, price closed at the highest price since November 11, 2014 after nearly 5 years of price below that level. It is kind of like the frog in the pot heating on the stove that does not realize what is happening until it is too late. In this case, price has been increasing, but it does not feel like it has due to multiple years of low prices with many farmers still struggling and some continuing to exit the dairy business.

Much focus has also been shifted to crop production and the uncertainty surrounding forage quality and feed supply this year. Some of the gain in milk price may be offset by higher feed bills due to increasing cost of feed ingredients. Rations will be balanced not only for maintaining milk production, but also for the health of the animal and body condition. 

It is interesting that even though cheese price has continued to slowly increase this year, Class III futures hold a discount to cash in 2020 contracts. Obviously, there is no way of knowing what milk prices will be that far out, but traders usually trade a seasonality with futures carrying a premium in anticipation of stronger prices. This year is quite different with the political uncertainty surrounding the tariff situation with China, the effects of African swine fever in China resulting in the significant decrease of dry whey and lactose imports. The other political aspect is the completion of a trade agreement with Japan to maintain dairy exports to the country.

Another aspect is that the past four years has shown how price increases have been short-lived resulting in no need to anticipate higher prices and no need to add premium to futures contracts that will eventually be taken out as contracts converge to cash. The past few months have seen contract prices increase as they move closer to settlement as price premium had to be added in order to converge to cash. This will continue until traders feel confident that the extended period of low prices has been left behind. This may take the rest of the year to accomplish. 

The final variation I want to touch on is the narrowing of the block/butter spread. There is always much discussion over the block/barrel spread, but there has been virtually no discussion on the narrowing block/butter spread. Butter price has declined substantially since July 16th while block cheese price has climbed. This puts the block/butter spread at 17 1/2 cents and the narrowest spread since November 2016. This is clearly reflecting the lack of export business this year as year-to-date exports are now 40% lower compared to a year ago. Years ago, butter and blocks followed each other more closely in price, but that has changed during the past decade. 

We can be sure that there will be more variations of the usual or historical yet this year, but what we do hope is that milk prices continue to rise and hopefully give us at least as many good years as the low years we have just been through.